Key Highlights

  • Input prices hit a 3-year high: The ISM price index jumped 7.7 points to 70.7, the largest single-month surge in over 13 years, fuelled by spiking fuel costs tied to the US-Iran conflict and persistent tariff-driven cost inflation.
  • Services growth decelerates sharply: The PMI fell from 56.1 to 54.0, missing forecasts, with employment contracting to its lowest since December 2023, raising the spectre of stagflation in the economy's dominant sector.
  • The Fed is boxed in: Strong new orders suggest demand hasn't collapsed, but accelerating inflation alongside softening employment makes rate cuts politically and economically difficult to justify, with most economists now expecting rates on hold well into late 2026.

US services sector activity slowed more than expected in March while businesses paid the most for inputs in over three years, as the prolonged war with Iran layered fresh inflationary pressure onto an economy already grappling with the fallout from sweeping import tariffs.

The Institute for Supply Management's non-manufacturing purchasing managers' index fell to 54.0 in March from 56.1 in February, below the 54.9 economists had forecast, marking the sharpest monthly deceleration since late 2023. The services sector accounts for more than two-thirds of US economic output.

The Price Shock Is the Story

The headline slowdown was troubling. The price data was worse. The ISM's measure of input costs paid by businesses surged 7.7 percentage points to 70.7, the highest reading since October 2022 and the largest single-month jump in more than 13 years. The gauge has now remained above 60 for 16 consecutive months, a run of sustained price pressure that will test the Federal Reserve's resolve to hold rates steady.

Steve Miller, chair of the ISM Services Business Survey Committee, pointed to broad-based cost increases: "Companies across many industries reported seeing higher gas and diesel pricing. Construction products such as lumber, copper and steel were noted as up in price."

The proximate cause is unmistakable. The US-Israeli war with Iran, now entering its second month, has driven global oil prices up more than 50 per cent, pushing the national average retail gasoline price above $4 a gallon for the first time in nearly four years. Threats to close the Strait of Hormuz are raising war-risk surcharges across regional logistics networks, with wholesalers warning that "landed costs have increased materially" and real estate businesses describing "an additional layer of uncertainty on top of an already shaky macroeconomic climate."

Economists expect the full inflation impact of the conflict to crystallise in Friday's March Consumer Price Index report. Producer prices had already surged in February in anticipation of the escalation.

Tariffs: Still in the Picture

The Iran conflict has not displaced tariffs as a source of corporate anxiety; it has compounded them. President Trump's sweeping tariff regime, though struck down by the US Supreme Court, remains operative after the administration imposed a global tariff for up to 150 days in response to the ruling. Businesses in accommodation and food services noted that while some tariff rollbacks produced "favourable price adjustments," fresh implementation announcements were "driving continued uncertainty."

Supplier delivery times lengthened, with the relevant ISM gauge rising to 56.2 from 53.9 in February. Back-orders and a shortage of trucks are contributing to delays across the supply chain.

A Fed With No Easy Exit

The data place the Federal Reserve in an increasingly uncomfortable position. New orders rose to a two-year high of 60.6, evidence that underlying demand has not collapsed, but employment in the services sector contracted to its lowest level since December 2023, and the inflation picture is deteriorating rapidly.

"With employment softening and inflation pressures flaring up again, the data suggest slower growth alongside sticky price pressures," said Priscilla Thiagamoorthy, senior economist at BMO Capital Markets. "This keeps the Fed in a difficult position and reinforces the case for patience."

The Fed left its benchmark rate in the 3.50–3.75 per cent range at its last meeting. Market expectations for a cut this year have diminished sharply in the wake of the conflict. John Ryding, chief economic adviser at Brean Capital, was blunter: "ISM prices paid is a very useful indicator of trends in inflation, and this reading should be disconcerting to the Fed; it is consistent with inflation running close to 4 per cent."

US equities traded higher following the release. Treasury yields were steady and the dollar little changed, suggesting markets are, for now, choosing to focus on the resilience in new orders over the deterioration in prices and employment.